Ch13 Economic Challenges

Unemployment Frictional Unemployment – Looking for new work Seasonal Unemployment – Farm work, Holiday Seasons Structural Unemployment – Changing workplace Cyclical Unemployment – Business Cycles Underemployed – More qualified than job requires Discouraged workers

Inflation Inflation is the general increase in prices over time Inflation vs. Purchasing Power – How much do you get? Inflation is usually measured by looking at groups of common goods in a price index

Causes of Inflation Quantity Theory – Too much money in the supply Demand-Pull Theory – Demand for goods exceeds supply Cost-Push Theory – Costs for making goods increases Wage–Price Spiral – The wage price spiral is where wages increase, causing increased demand, causing prices to go up, leading to a need for higher wages, etc.

Short-Run Trade-Off between Inflation and Unemployment Unemployment and Inflation Society faces a short-run tradeoff between unemployment and inflation. If policymakers expand aggregate demand, they can lower unemployment, but only at the cost of higher inflation. If they contract aggregate demand, they can lower inflation, but at the cost of temporarily higher unemployment. The Phillips Curve shows the short-run trade off between inflation and unemployment.

The Phillips Curve Inflation Rate (percent Phillips curve per year) 4 B 6 7 A 2 Unemployment Rate (percent)

How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve Price Inflation Level Short-run aggregate supply High aggregate demand Rate (percent Phillips curve per year) Low aggregate demand (output is 8,000) B 4 6 8,000 (unemployment is 4%) 106 B (unemployment is 7%) 7,500 102 A (output is 7,500) A 7 2 Quantity Unemployment of Output Rate (percent)

An Adverse Shock to Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve Price Inflation 4. . . . giving policymakers a less favorable tradeoff between unemployment and inflation. Level AS2 Rate Aggregate PC2 B supply, AS 1. An adverse shift in aggregate supply . . . B P2 Y2 3. . . . and raises the price level . . . P A Y A Aggregate demand Phillips curve, P C Quantity Unemployment 2. . . . lowers output . . . of Output Rate

Disinflationary Monetary Policy in the Short Run and the Long Run 1. Contractionary policy moves the economy down along the short-run Phillips curve . . . Inflation Long-run Rate Phillips curve Short-run Phillips curve with high expected inflation A Short-run Phillips curve with low expected inflation C B 2. . . . but in the long run, expected inflation falls, and the short-run Phillips curve shifts to the left. Natural rate of Unemployment unemployment Rate

The Long-Run Phillips Curve Inflation Rate Long-run Phillips curve B High inflation 1. When the Fed increases the growth rate of the money supply, the rate of inflation increases . . . 2. . . . but unemployment remains at its natural rate in the long run. Low inflation A Natural rate of Unemployment unemployment Rate

How the Phillips Curve is Related to Aggregate Demand and Aggregate Supply (a) The Model of Aggregate Demand and Aggregate Supply (b) The Phillips Curve Price Long-run aggregate Inflation Long-run Phillips Level Rate supply curve 1. An increase in the money supply increases aggregate demand . . . 3. . . . and increases the inflation rate . . . AD2 P2 B B 2. . . . raises the price level . . . A P A Aggregate demand, AD Natural rate Quantity Natural rate of Unemployment of output of Output unemployment Rate 4. . . . but leaves output and unemployment at their natural rates.

SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS Historical events have shown that the short-run Phillips curve can shift due to changes in expectations. The short-run Phillips curve also shifts because of shocks to aggregate supply. Major adverse changes in aggregate supply can worsen the short-run trade-off between unemployment and inflation. An adverse supply shock gives policymakers a less favorable trade-off between inflation and unemployment.

The Phillips Curve in the 1960s Inflation Rate (percent per year) 10 8 6 1968 4 1966 1967 2 1965 1962 1964 1961 1963 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent)

The Breakdown of the Phillips Curve Inflation Rate (percent per year) 10 8 6 1973 1970 1971 1969 4 1968 1972 1966 1967 2 1965 1962 1964 1961 1963 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent)

The Supply Shocks of the 1970s Inflation Rate (percent per year) 10 1981 1980 1975 1974 1979 8 1978 6 1977 1976 1973 4 1972 2 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent)

The Volcker Disinflation Inflation Rate (percent per year) 10 1980 1981 1979 A 8 1982 6 1984 1983 B 4 1987 C 1985 1986 2 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent)

The Greenspan Era 10 8 6 4 2 1 2 3 4 5 6 7 8 9 10 Inflation Rate (percent per year) 10 8 6 1990 4 1991 1989 1984 1988 1985 1987 2001 1995 2000 1992 1993 2 1994 1986 1997 1996 1999 1998 2002 1 2 3 4 5 6 7 8 9 10 Unemployment Rate (percent)

Poverty The poverty threshold is the income level needed to support a families minimum needs Family of 4 (2 adults, 2 children) $18,850/yr (2004) Poverty depends on family size and location

Reasons for poverty Lack of education Location Racial and Gender Discrimination Economic Shifts Family Problems Health Greed

Income Distribution In 2003, median family income was $43,318 (half earned more, half less) The Lorenz Curve shows that the wealthiest 20% made as much as the other 80% of Americans The GDP (Gross Domestic Product) of the poorest 48 nations (i.e. a quarter of the world’s countries) is less than the wealth of the world’s three richest people combined. In the 1970, the top 1% made less than 9% of all income, in 2007, the top 1% took in more than 27% of all income

Welfare Reform Many poor receive Federal Aid, in the form of housing subsidies, food stamps, direct cash payments, and health related services. In 1996, welfare reform was enacted because there was a growing perception that the poor were living off of the state, creating a tax burden for everyone else. This welfare reform reduced payments, and gave some training assistance, to get people into the work force.

End